By Justin Fundalinski, MBA | July 15, 2016
We have all heard about trickle-down economics – in its most basic sense it argues that over time tax breaks for large corporations and investors (the wealthy) will stimulate economic growth as they will be able spend more money in the economy rather than on taxes. Well, I have decided to coin a new term called trickle-down taxes – in its most basic sense I argue that tax law changes can get overwhelming bi-partisan support if they are presented to look like a tax on the wealthy, however over time because of how the tax is designed it slowly drags in and affects large proportions of the middle class. In this month’s newsletter I will give a historical example of how this has occurred with Social Security taxation and a more contemporary example of how this is occurring with Medicare Premiums.
Social Security Example:
First, some history
In 1983 amendments were passed and Social Security first became taxable in 1984. These changes were branded by Ronald Reagan, Alan Greenspan, and a bi-partisan congress as a way to shore up Social Security so that it would exist in the future. Then in 1993, during massive budget reconciliation, Vice President Al Gore cast the deciding vote for a deadlocked congress (50/50) to bring Social Security taxation laws to their current state and was signed into law by President Bill Clinton. This change was directly branded to affect only “higher income” beneficiaries.
Second, some cynicism
What really was not brought to directly to the public’s attention were the sneaky little details of these tax law changes that would over time effect more and more people than the “higher income” beneficiaries it was branded to affect.
Last month I went into a lot of detail about how Social Security income is currently taxed. I discussed specifically how Social Security taxation gets phased as a comparison of “Provisional Income” to a “Base Amount” and an “Adjusted Base Amount.” Typically, when tax rules are phased in/out they are based off a figure made up in the law (i.e. Roth IRA contribution limits) and this figure is usually adjusted for inflation every year so that as inflation affects income levels the tax impact does not grow year over year. Unfortunately, when it comes to the Base Amount and the Adjusted Base Amount, these figures are not adjusted for inflation. They remain the same indefinitely!
Third, some numbers behind my cynicism
Let’s just look at the Base Amount (which was established in the 1983 amendment) and Adjusted Base Amount (which was established in the 1993 budget reconciliation). In 1983 any married couple that had Provisional Income greater than $32,000 would have their taxable Social Security income phased in up to a maximum of 50%. Had this figure been adjusted for inflation like most tax phase in/outs, it would have grown to over $72,000(assuming an average 2.5% inflation rate for simplicity)! But no, currently in 2016 the Base Amount still sits at $32,000! So, this year and all future years, any married retirees that have Provisional Income greater than $32,000 gets affected by this tax. This very concept also applies to the Adjusted Base Amount.
You can see how these law changes seemingly only affected high income retirees when they were established, but now in 2016 they affect more and more of the middle class. Given more time, I am sure that nearly everybody with a Social Security benefit will be affected.
Back in October 2015’s newsletter I spoke extensively about Medicare premiums. To sum it up, there are five different Medicare premium levels and they are based on the income levels of the Medicare recipient. The first bracket is the most common and the majority of people fall into this category. However, if someone earns too much income in a year they are forced into what is called an “Income Related Premium” and must pay higher Medicare premiums.
Historically, these Medicare brackets have been adjusted for inflation and would grow proportionately as income naturally would grow. However, these brackets became “frozen” under the Affordable Care Act (AKA Obamacare) and are intended to remain frozen only until 2019 (I’m not a betting man, but I would put money on it that 2019 is a hopeful dream). So what are the affects? Well, as income grows and the brackets remain frozen, more and more people are forced into higher Medicare premiums. According to a Kaiser Family Foundation study, it is estimated that between 2013 and 2019 the percentage of Medicare beneficiaries that must pay income related premiums will nearly double from 4.6% to 8.3%.
Imagine what will happen if these brackets remain “frozen” indefinitely. More and more people will be forced to pay Income Related Premiums. It seems like only high income earners are affected by this effective tax on Medicare premiums right now, but give it some time and it will begin to look eerily similar to what happened with Social Security taxation.
As you can see from the Social Security and Medicare examples above, if a tax law is designed in a way that it disregards the effects of inflation on income, over time the tax will trickle-down from high income earners/retirees to the majority of the population. Trickle-down taxes are essentially a way to increase taxes every year without having to publicly announce an income tax hike.
In a stretch for irony, one might find it entertaining that my concept of trickle-down taxes is first evidenced in 1983 under a supply-side economic policy under President Reagan (AKA “Reaganomics”). Supply-side economics is essentially trickle-down economics.
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